Solutions – Chapter 2

Problem 2-1
Year 5

Investment in Robbin 275,000

Cash 275,000

Cash (40,000 x 20%) 8,000

Dividend income 8,000
Record dividend revenue declared and paid for Baskins Investment

Investment in Robbin (20,000 shares x 16 – 275,000) 45,000

Unrealized gain on FVTPL investment 45,000
Record the revaluation of Investment

Year 6
Investment in Robbin (90,000 x 20%) 18,000
Equity method income 18,000
Share of Robbin’s income

Cash (40,000 x 20%) 8,000

Investment in Robbin 8,000
Baskin’s share of dividends declared by Robbin

Cash (20,000 x 17) 340,000

Investment in Robbin (275,000 + 45,000 + 18,000 - 8,000) 330,000
Gain on sale 10,000
Sale of investment in Robbin
Problem 2-3
(a)
Investment account at end of Year 6 under cost method = Original cost of $42,000
Investment account at end of Year 6 under equity method:
Year 5 Year 6
Investment, beginning of year 0 44,400
Cost 42,000 -
Equity method income (20%) 5,000 5,600
Unrealized gain (1,300)
Dividends received (20%) (2,600) (2,800)
Investment, end of year 44,400 45,900

(b)
Investment income for Year 6 under cost method = Dividend income of $2,800
Investment income for Year 6 under equity method: = 5,600 – 1,300 = $4,300

(c) Cost Equity

Cash 47,000 47,000
Investment in Raymore (42,000) (45,900)
Gain on sale of investment (5,000) (1,100)
Problem 2-4

(a)

January 1, Year 5

Investment in Stergis 1,950,000

Cash 1,950,000
To record purchase of 25% of Stergis.

December 31, Year 5

Investment in Stergis 13,650

Equity method income 13,650
To record 25% of Stergis’s Year 5 net income.
25% x $54,600 = $13,650

Investment in Stergis 2,950

OCI - Equity method income 2,950
To record 25% of Stergis’s Year 5 OCI
25% x $11,800 = $2,950

Cash 19,500
Investment in Stergis 19,500
To record 25% of Stergis’s Year 5 dividends.
25% x $78,000 = $19,500

December 31, Year 6

Investment in Stergis 39,000

Equity method income 39,000
To record 25% of Stergis’s Year 6 net income.
25% x $156,000 = $39,000

Investment in Stergis 7,800

OCI - Equity method income 7,800
To record 25% of Stergis’s Year 6 OCI
25% x $31,200 = $7,800
 Cash 19,500
Investment in Stergis 19, 500
To record 25% of Stergis’s Year 6 dividends.
25% x $78,000 = $19,500

(b)

January 1, Year 5

Investment in Stergis 1,950,000

Cash 1,950,000
To record purchase of 25% of Stergis.

December 31, Year 5

Cash 19,500*
Dividend income** 19,500

To record 25% of Stergis’s Year 5 dividends*

*25% x $78,000 = $19,500

December 31, Year 6

Cash 19,500
Dividend income 19,500
To record 25% of Stergis’s Year 6 dividends.

(c)
Blake would prefer to use the equity method. Since Stergis’ comprehensive income for Years 5
and 6 is greater than dividends paid for Year 5 and 6, Blake’s comprehensive income would be
higher under the equity method. In turn, shareholders’ equity will be higher and total debt will
remain the same. Therefore, the debt-to-equity ratio will be lowest under the equity method.
Problem 2-6
Part (a) Equity method

(i) Investment in Saltspring 285,000

Cash 285,000
To record 30% investment in Saltspring

Cash (30% x 110,000) 33,000

Investment in Saltspring 33,000
Dividends received

Investment in Saltspring (30% x 306,000) 91,800

Equity method loss – discontinued operations (30% x 33,000) 9,900
Equity method income (30% x 339,000) 101,700
To record 30% of Saltspring’ s profit and discontinued operations

(ii) Investment cost Jan. 1, Year 6 $285,000

Dividends received (33,000)
Share of income 91,800
Investment account Dec. 31, Year 6 $343,800

(iii)
Pender Corp
Statement of Operations
Year ended December 31, Year 6

Sales $990,000
Equity method income 101,700
1,091,700
Operating expenses (110,000)
Income before income tax 981,700
Income tax expense (352,000)
Net income before discontinued operations 629,700
Disc. Operations – Equity method loss (9,900)
Profit $619,800
Part (b) Cost method

(i) Investment in Saltspring 285,000

Cash 285,000
To record 30% investment in Saltspring

Cash 33,000
Dividend income 33,000
Dividends received

(ii) Investment account balance December 31, Year 6 $285,000

(iii)
Pender Corp
Statement of Operations
Year ended December 31, Year 6
Sales $990,000
Dividend income 33,000
1,023,000
Operating expenses (110,000)
Income before income tax 913,000
Income tax expense (352,000)
Profit $561,000

Part (c)

Pender would want to use the equity method if its bias were to show the highest return on
investment since the equity method considers the full increase in value of the investee (i.e.
recognizes proportion of income earned for the year) whereas the cost method only recognizes
income to the extent of dividends received.

Cost method return on investment = $33,000/ $285,000 = 11.58%

Equity method return on investment = ($101,700 - $9,900)/ $285,000 = 32.21%